Planned Shortages with Back-Orders

Shortage: when customer demand cannot be met Planned shortages could be beneficial
Cost of keeping item is more expensive than the profit from selling it Ex: car

Alternatives for customers when their demand cannot be met from stock

Customer Demands an item

Customer demands an item

The item is out of stock

Back Order Customer waits for the next replenishment

Lost Sales Customer moves to another suppliers

Customer keeps all future businesses

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Customer transfers some future business to another supplier

Customer transfers some future business to another supplier

Customer transfers all future business to another supplier

Planned Shortages with Back-Orders

Optimal order size

Qo =

2 RC D (HC + SC ) HC SC
2 RC HC D SC ( HC + SC )

Optimal amount to be backordered

Time during which demand is met Time during which demand is back-ordered Cycle time

So =

T1 = (Qo S o ) / D T2 = S o / D T = T1 + T2
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Ex 4: Back order
Demand for an item is constant at 100 units a month. Unit cost is $50 Reorder cost is $50 Holding cost is 25% of value a year Shortage cost for back order is 40% of value a year Find an optimal inventory policy for the item
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IM 322 Inventory Management

Chapter 5 Models for Uncertain Demand
Textbook: Donald Waters, Inventory Control and Management, 2nd ed

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Chapter Outline
Uncertainty in inventory management Variables that take uncertain value Probabilistic models for inventory model Uncertain demand Uncertain lead time Service level / safety stock
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Areas of Uncertainty
For example Changes in customer demand during leadtime Price uncertainty Operations change New products Disrupted supply chain Trading conditions etc

Uncertain Demand
Q Inventory level

Reorder point, R

0 LT Time Lead time demand LT

Uncertain Demand Safety Stock

Buffer added to on hand inventory during lead time Extra reserved stock To prevent stockout under Q Reorder uncertain demand point, R Safety stock will not normally be used, but it is available under uncertain demand 0 How much safety stock should we hold? Judgment on service level
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Inventory level

Safety Stock

LT

Time

LT

Service Level

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Service Level
Several ways of measuring the service level
Percentage of order completely satisfied from stock Percentage of units demanded that are delivered from stock Percentage of units demanded that are delivered on time Percentage of time there is stock available Percentage of stock cycles without shortages Percentages of item-months there is stock available

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Reorder Level
Reorder Level (ROL) Reorder Level (ROL) Reorder Level (ROL) Reorder Level (ROL)
Inventory level

= = = =

LT x D LT x D (LT x D) + Safety Stock (LT x D) + Safety Stock

Reorder point, R Safety Stock

0
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LT

Time

LT

Reorder Point for a Service Level

Probability of meeting demand during lead time = service level

Average demand during lead time

Probability of a stockout

Safety stock z LT Demand

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Reorder Point with Uncertain Demand

Reorder point with safety stock Service level = probability of NO stockout

L
Standard deviation during leadtime Safety Stock

ROL = (LT D ) + z LT

d = average demand L = lead time t = standard deviation of demand

z = number of standard deviations correspond ing to the service level probabilit y z t

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L = safety stock

Ex 1: Uncertain Demand
PM Computers assembles microcomputers from generic components. It purchases its color monitors from a manufacturer in Taiwan. There is a long lead time of 25 days. Daily demand is normally distributed with a mean of 2.5 monitors and a standard deviation of 1.2 monitors. Determine the safety stock and reorder point corresponding to a 90% service level

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Ex 2 Uncertain Demand
ABC company finds that demand for an item is normally distributed with a mean of 2,000 units a year and standard deviation of 400 units. Unit cost is $100, reorder cost is $200, holding cost is 20% of value a year and lead time is fixed at 3 weeks. Describe an ordering policy that gives a 95% service level. What is the cost of safety stock?

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